Running head;THE CONCEPT OF COMPOUNDING 1

THE CONCEPT OF COMPOUNDING

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Compounding is the process of an asset's value increasing as interest is earned on both the

principal and the accrued interest.Over time, capital gains or interest are reinvested to generate

further income.Compounding is the process of crediting interest to an existing principal amount

as well as previously paid interest. .This phenomena is a clear manifestation of the temporal

value of money.Compound interest is another name for this phenomenon. Interest on interest is a

way to describe compounding.

Time and the frequency of the compounding period are very key factors when it comes to

compounding.Compounding's effects become stronger as the frequency of compounding

increases. In the case of a one-year period, the greater the number of compounding periods

throughout that one-year period, the larger the investment's future worth. The higher the

investment, the longer the compounding period.It is often referred to as the miracle of

copounding.

In a process called continuous compounding, the frequency of compounding over a set period of

time has a limited effect on time growth It grows as a result of the investment's initial principle

and the accumulated earnings from previous periods. Money is more valuable in the present than

in the future because it can produce compound interest, which is based on the premise that

people would prefer have money now than in the future.

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NET PRESENT VALUE

It is a discounted method that takes into account the time value of money when appraising capital

investment.The cost of capital is used as a discount rate for determining the present value of

cashflows in and out of an investment project.As a result of this technique, a corporation can

determine how much money will be coming in or going out of different projects in order to

determine their profitability. As a result of this strategy, all cash flows, including incoming and

outgoing ones, will be discounted. Values that have been estimated have been used to calculate

cashflows.

This concept is based on the time worth of money. Money is more valuable in the now than it

will be in the future because its purchasing power diminishes with time. Inflation, for example, is

to blame for this. As a result, investors discount any future value of money they will receive to

the present value. Discounting is the process of transforming future worth into current value. We

discount using a discounting factor and a percentage rate.

Net present value (NPV) is calculated by using a formula

Whereby,the future value FV is converted to the present value PV by using a discount factor

As a result of this, the net present value (NPV) of a project, including its initial capital

investment, is calculated. Profitability analysis is commonly used in capital planning to

determine which projects are most likely to be profitable.If the net present value is greater than

zero then the project is profitable .On the contrary,if the net present value is less than zero then

the project is unattractive.

THE SIGNIFICANCE OF NET PRESENT VALUE ON DESICIONMAKING

In order to grasp how money works and how to make wise decisions in the future, it is essential
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to understand current value. Moreover, understanding present value allows you to correctly

evaluate investment opportunities and make better financial decisions. By examining the

predicted outcome of a project, we may determine whether an investment will create value.

Unlike other investment ratios, it also takes into account all cash flows.

REFERENCES

In the joys of compounding;Gautam Baid

The oxford handbook of compounding;Rochelle leiber,Pavol Stekauer

Thepower of compounding;The secret of money making by Kritesh Abhishek

The concept of compounding interest;The 52 book challange